8/17/2009 @ 4:55PM

Profiting From The Low-Carbon Economy

Amid unprecedented market turmoil, many banks are now rightly focused on shoring up their short-term performance and even, in some cases, ensuring their survival. With so many open questions–How deeply will the global recession bite? How aggressively will regulators react to the crisis? How quickly can balance sheets be rebuilt?–long-term strategy has received little or no attention. And yet, almost unnoticed, one topic has advanced from distant issue to discernible opportunity: the transition to the low-carbon economy.

The global response to the problems of climate change will entail a massive shift of industrial and financial resources. To cut emissions of greenhouse gases (especially carbon dioxide), consumers, companies, industries and even entire countries will have to abandon current forms of carbon-based consumption and switch to new, less-polluting alternatives. Vast sums of capital will be required to fund emission-reducing projects and infrastructure. New industries will be forged, going far beyond the nascent companies we see today. New financial products and markets will be necessary to manage and transfer the risks and costs of carbon emissions. Increasingly forceful regulatory intervention will drive unprecedented shifts in cash flows and valuations. Investors and regulators will demand better information about the economic impact of climate change.

This shift has already begun. And as cap-and-trade schemes and other regulations proliferate and more companies and industries come within their ambit, the need for financing and trading will grow enormously. Banks, investors and exchanges have critical roles to play in shaping this transition to a low-carbon economy. Speaking in January 2009 at the World Economic Forum in Davos, Lord Stern, author of one of the most influential reports on the impact and costs of climate change, had the following to say about the role and opportunities that climate change could create for banks:

Banking could do very well as [the world] moves toward a low-carbon economy. There will be lots of business opportunities. … [B]ankers are particularly strong in this area. They have been very creative over all kinds of issues and they could do it again in the financing of green initiatives.

By our reckoning, banks’ revenues from just a small subset of carbon trading and infrastructure financing and advisory activities may reach $15 billion in 2020; industry revenues today from all corporate and investment banking activity are in the vicinity of $250 billion. Although responding to climate change will not fully ease banks’ current woes, it can nevertheless be an important part of the puzzle–and one that banks overlook at their cost.

The Future Has Arrived

Already, climate change is altering the business environment in which banks and their clients operate. Many parts of the world have begun to ask the businesses to bear the costs of the carbon emissions they create. The European Union, for example, has agreed to widen the range of industries covered by its pioneering Emissions Trading Scheme (ETS) and to enforce on these industries a minimum 21% reduction of carbon emissions (from 2005 levels) by 2020. The E.U. has also left the door open to tighten the target further. The new U.S. Congress has suggested that by 2020, the United States must reduce its emissions by 17% from 2005 levels, in part by implementing a cap-and-trade system that will cover 66% of U.S. emissions. Similar schemes are planned for Australia and under discussion in Canada, Japan and New Zealand. And such action is not limited to the developed world; Mexico and South Africa, for example, have both made formal commitments to reduce emissions.